Home Equity as Retirement Savings: Not So Hot

by Alex Stenback on April 10, 2007

Earlier today in the Linklube (see previous post) we linked to a paper from the Fidelity Research Institute that examines the role of home equity (as opposed to other types of investments) in financing one’s retirement.  Now that we’ve had chance to read it in detail, we wanted to hit the high points for those of you that don’t have the stamina to get through all 32 pages.

The conclusion, which may be counterintuitive to many readers:  Though owning a home is clearly a better option over the long haul than renting (obvious, that part) home equity as a strategy to finance retirement is a bad idea, and over the long term real estate is the worst performer (see chart at right, click for big,) among other investments such as stocks, bonds, etc. – barely edging out super-low risk treasury bills. 

There’s also this: over-investing in real estate (either by over buying, or pre-paying a mortgage) is the wrong thing to do in planning to finance retirement.  From the article:

Another way to inadvertently “over-invest” in real estate may be by paying off a home’s mortgage early….a significant number of households are actually doing the wrong thing when they accelerate their mortgage payments. For certain segments of this group, it would be more beneficial to put these extra payments into their tax-deferred retirement accounts…

Among the other interesting data points (more in bullet form, plus a link to the report, after the jump) is the following chart, which compares real estate investment returns to other investments over time – fascinating stuff -  the whole report is worth a read.

Click Image for Larger Graphic

u1. Despite the recent run up in mortgage debt, net home equity stands at well over 50% of total home values – there is a LOT of equity yet to be tapped.
2.  The Median Price of New Homes has averaged a 5.9% annual appreciation rate since 1963.
3.  Returns on a dollar invested in real estate in 1963 have been only slightly better than returns on low risk treasury bills.
4. Real estate in the form of home prices has not had attractive risk and return characteristics over long periods of time.

5. Do NOT Over invest: Stretching to buy a much larger, more expensive house than a person actually needs could cost a “house-rich, cash-poor” homeowner a major “opportunity” loss in foregoing historically high-returning stock investments for lower-returning real estate assets.
6.  Another way to inadvertently “over-invest” in real estate may be by paying off
a home’s mortgage early.

Of course, even with careful and correct planning most of us will at some point have accumulated substantial home equity, and the paper goes on to discuss different tactics to deploy this equity to fund retirement – reverse mortgages, downsizing, Home Equity Extraction (cash out "re-fi" or HELOC.)

If you are serious about home onwership and retirement planning, this is a must read.
The Equity You Live in: The Home asa Retirement Savings and Income Option [PDF]

{ 3 comments… read them below or add one }

John Yedinak April 10, 2007 at 11:04 am

If you are 62 or older a reverse mortgage is a safer way to go than using a HELOC. There is no recourse on a reverse mortgage and you dont need any income to qualify.

Just my two cents.


Editor April 10, 2007 at 12:48 pm

John –

Easier to qualify for? Yes?

Safer? Maybe, in that the lender does not have the power to force a sale.

We around here are of the opinion that a reverse mortgage is suitable for a very small slice of american hoemowners who are over 62 and have little or no assets outside of home equity. And the fees on most reverse mortgages are out of control.

Teresa Boardman April 11, 2007 at 6:37 am

On the other hand having a home that is paid for does make retirement easier.

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